Kaiser Blog: The Bre-X Court Decision - Tommy Franks you are so wrong!

Kaiser Blog: The Bre-X Court Decision - Tommy Franks you are so wrong!

July 31, 2007

In his book about the American invasion of Iraq, "Plan of Attack", American journalist Bob Woodward presents a choice quote from General Tommy Franks that Douglas Feith, former Under Secretary of Defense for Policy, is "the fucking stupidest guy on the face of the earth." Apart from former Secretary of Defense Donald Rumsfeld, Tommy Franks' assessment of Feith has not met a serious challenge. Until today. On July 31, 2007, more than ten years after the greatest gold mining hoax in the history of the world was exposed, Justice Peter Hryn of the Ontario Superior Court ruled that the various "red flags" that should have alerted John Felderhof of Bre-X Minerals that something was wrong with his 200 million ounce Busang gold discovery in Indonesia were not obvious, and accordingly he exonerated John Felderhof of all the insider trading and false press release charges the Ontario Securities Commission had brought against John Felderhof on May 11, 1999.

In doing so Justice Peter Hryn pretty much killed all class action lawsuits pending against peripheral players such as the Canadian brokerage firms named in the class action lawsuit by US based Sutts Strossberg LLP, for if the man who had absolute decision making power with regard to Bre-X's Indonesian operations had no way to avoid being a dupe like everybody else, how can anybody else be blamed for taking on face value the disclosures provided by Bre-X? A Globe and Mail article quotes Felderhof's lawyer Joseph Groia as stating "I think all investors should be somewhat pleased because what this shows is that, notwithstanding the huge pressure that this case has brought to bear on everyone, the justice system has worked". General Tommy Franks, you owe Douglas Feith an apology!

During the past couple of days I have reread "Bre-X: Gold Today Gone Tomorrow" by Northern Miner journalists Vivian Danielson and James Whyte, the "Busang Project - Technical Audit" by Graham Farquharson's Strathcona Mineral Services, the Statement of Claim filed by class action lawyers Sutts Strossberg, Felderhof's Statement of Defence, and all kinds of historical stuff in my Bre-X file. All of this has confirmed my belief that Busang was a fraud orchestrated by Bre-X's Indonesian operations which were overseen by John Felderhof, a man I have always regarded as fundamentally shrewd. To this day I believe that David Walsh, Paul Kavanagh and the entire Calgary Bre-X contingent were indeed hook-line-and-sinker suckers in this play whose unwavering true believer mode blinded them to everything that seemed odd or out of place. They were the perfect patsies. I do have my suspicions about the players whose participation in the May 1994 $4.5 million private placement at $1.50 brokered by Loewen Ondaatje McCutcheon seemed rather strange for an exotic offshore mineral play run by a couple of drunks who had attracted an audience of mom and pop speculators who lacked the sophistication to turn up their noses at Bre-X. For it was the involvement of this carefully not identified group of placees which paved the way for Nesbitt Burns and Egizo Bianchini, a firm and analyst noted for textbook investment strategies who became the perfect marks for escalating this story to unstoppable freighttrain status. But I have my doubts that even this LOM group perceived Bre-X as anything more than a good pump and dump story, and I have a hard time believing that Busang was a far-flung conspiracy. I am still inclined to believe that Busang was cooked up as a small-time fraud that grew far beyond anybody's expectations, growing into a violent tiger which had to be fed and fed by those who had it by the tail or risk being devoured by the tiger. I am inclined to view John Felderhof not as a creator of the tiger, but as somebody who found himself riding the tiger and who was in a position to put a bullet into the head of the tiger no later than mid 1996. He did not kill the tiger, and as late as December 17, 2001 in his statement of defence against a class action lawsuit he makes statements which suggest that, in the immortal words of newsletter writer Mike Schaefer, "the hoax is the hoax". If there was anybody in a position to stop the Busang hoax, it was John Felderhof. The decision by Justice Peter Hryn in effect says, no, that was not the case, at least not in the sense of having reason to stop the fraud.

I have not seen the 594 page decision - the Ontario Superior Court of Justice and the Canadian Legal Information Institute apparently do not have the same day capacity to convert a WORD document to a pdf file, ftp it to the CANLII web site, and code up a link to the document such as a tiny operation like Kaiser Bottom-Fish Online can readily do with its own web site - so I will reserve judgement with regard to who now bears the crown General Tommy Franks had bestowed on Douglas Feith.

Is it John Felderhof, who told numerous potential suitors to take a hike when they offered good deals with the proviso that they be allowed to drill confirmation holes? Who co-authored a marvelous "scientific" geological paper on "Mineralization in a Maar Diatreme - Dome Complex" with Michael de Guzman, Cesar Puspos and Jonathan Nassey, but who exhibited zero interest in conducting polished and thin section studies in an effort to understand the relationship of the gold to the host mineralogy of this astonishing one of a kind deposit? Whose curiosity was not aroused by the odd observations about the nature of the Busang gold in reports by metallurgical facilities such as Normet and Hazen? Who chose to retreat into an administrative role in Jakarta rather than ride shotgun along with his Filipino crew as it gloriously marched along the Southeast Zone toward the 200 million ounces he inferred from the footprint implied by the surface geology? Who bullied dissenters and critics by calling into question their professional competence? Who had a direct line to God's ear according to a mining analyst who worked with me on a summer internship during the eighties as a geologist-with-minimal-field-experience-working-on-his-MBA who manually crunched spreadsheet net present values on a handheld calculator because our brokerage firm was too cheap to provide a desktop computer? And who did nothing more as the star Bre-X analyst.

Is it the Ontario Securities Commission which avoided the hard task of sorting out exactly how the fraud was executed, who was all involved, and perhaps finding out that the web of complicity extended into remarkably deep corners of the financial establishment? And who instead tried for a seemingly easy victory by slapping insider trading charges on an individual who probably was not an instigator of the Busang fraud, but who was in a position to recognize something was wrong fairly early in the game, and studiously distanced himself from the exploration process in a way that would rule him out as heir to the title of fucking stupidest guy on the face of the earth? Who in botching their pursuit of justice perhaps shielded Canadian financial institutions from huge liabilities?

Is it Justice Peter Hryn, whose 594 page explanation of how red and green flags are indistinguishable I eagerly await the opportunity to read? Who seems to be telling us that geologists and engineers are intrinsically incompetent, and can never be counted on to smell manure and call bullshit?

Or is it lawyer Joseph Groia, who seems to think that General Tommy Franks should have leveled his accusation at everybody except that triumvirate of "color-blind" Justice Peter Hryn, "chief administrator" John Felderhof, and "defender of people of faith" Joseph Groia?

How fucking stupid do these guys think we are?

It is perhaps inevitable that the Canadian justice system would close the Busang case while leaving it wide open. But don't let this discourage you, prompt you to think that investors and speculators can never count on "wysiwig", the primary principle regulators can be expected to enforce, namely "what you see is what you get". The NI 43-101 reform introduced by the regulators in the wake of Busang has made it much more difficult to pull off a scam in the style of Bre-X. If anything it has forced scams to pursue a new level of sophistication that borrows heavily from the dot-com bubble era where the delusion is in the form of undue expectations craftily engineered into place rather than outright falsification of the information on which expectations are based. I have been highly critical of one such play, and you will not see a catastrophic collapse of it. Rather, it will just fade away as gradually more disappointing results lower the stock price into its grave. No, it has nothing to do with gold.

Recent revelations that results related to the Boka gold project in China of Southwestern Resources Corp (SWG-T: $2.79) may have been compromised may encourage people to think that the NI 43-101 reforms are meaningless, that in the context of John Felderhof being legitimately oblivious to red flags according to Justice Hryn nothing has really changed. But Boka is different. During its initial days in late 2002 management tried to spin its potential as something that wasn't quite supported by the geology when viewed up close, and as drill results described what was really there, management struggled to preserve the illusion that this was a bulk tonnage disseminated gold system amenable to open pit mining. When management refused to accommodate analyst requests for assay interval breakdowns of the results, the market in general lost interest. Yeah, you're stretching narrow structurally controlled gold spikes over low grade intervals to make Boka look more continuous than it really was. Gold was present at Boka, but it was structurally controlled in a complex setting, not the lithologically controlled layer cake model on which initial hopes had been pinned. Southwestern's former CEO, John Paterson, is now reportedly in the hospital with clinical depression several weeks after abruptly resigning in the wake of questions that quality control of the data generation process may have been below standard. But the bluesky had already faded away a couple years ago.

Boka's 3 million ounce resource is a consolation prize compared to initial expectations. It is what the complex geology allowed, and its economic value needed to be established by a prefeasibility study. The China based project manager has been fired, and Paterson is understandably distressed now that his pet project which had already fallen short of his initial hopes also seems to have been compromised in a manner that leaves him as the responsible party on whose watch it occurred. Details about the nature of the tampering have not been spelled out, but what I have been able to glean from the rumor mill is that the tampering was designed to distort the feasibility of mining Boka, not fabricate the existence of gold. In the words of Egizio Bianchini, the "gold is there", but its recoverable grade and mineable distribution may not be what initial studies suggested. Whereas Busang was an outright fabrication, Boka appears to be a distortion whose primary beneficiaries are local parties who would lose heavily in relative terms if Vancouver based management deemed Boka sub-economic and pulled the plug on further exploration or development expenditures. The problem for the company is now that it knows the information is compromised, it does not know which information to trust, and accordingly it has been forced to withdraw all statements.

One can flippantly declare that if John Felderhof can get away with ignoring metallurgical studies which describe the Busang gold as rounded grains similar to placer gold, John Paterson will easily be excused for missing subtle grade distortions in a system already characterized by erratic grades. But Boka never became a tiger anybody held by the tail and had to keep feeding. At the end of the day, Paterson may get his wrists slapped for not being hyper-vigilant, and chastised for becoming morose and uncooperative when things did not appear to be quite what results had presented them to be, but nobody can accuse him of standing Felderhof style on top of the Boka zone and declaring, "hell, the entire sponge is loaded with gold, about 100 million ounces of it, and I am not the fucking stupidest guy on the face of the earth for saying so". If there is any good that comes from the Felderhof decision, it is that class action predators will have a tougher time shaking down Canadian exploration juniors. But we should not let the Felderhof decision encourage us to junk 43-101.

*JK does not shares in any of the securities mentioned herein